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DIVERSIFICATION: THE HEDGE FOR SURVIVAL

THE NEED TO DIVERSIFY

"Other business" can be subcontracting, but this provides only temporary shelter and puts a company's future partly in the hands of others. "Other business," therefore, is better if it is permanent and fully under the company's control. Obviously, it is even better if it is not subject to government contract stretchouts, cutbacks, or cancellations. A wave of reductions, like those in 1957 and in the latter sixties, in which several orders are canceled in succession, can be fatal, even if a single one is not. Consequently, the aerospace companies have tried since World War II to diversify, seeking protection against failure to get or keep government business.

There are some parallels in the auto industry. Lawrence J. White has found that the few survivors in that business are the ones who successfully established multiple model lines.¹ This has enabled them to survive bad judgment in a particular model. Because of the long development time in autos-three years-recovery from an error in anyone line is delayed so long that financial and morale crises can set in. These crises do not become disasters when concurrent successful lines provide cash and confidence. The Edsel is a case in point, as is Kaiser's compact car, the Henry J.

Where cash and confidence are lacking, survival obviously is the goal of a company. In normal business, profits are regarded as the basic incentive. There is reason to believe that profit maximization does not perform this role in the aerospace industry; that survival is the permanent driving force. The use of an elite group of engineers to work from contract bid to bid, and not from the beginning on to the final design and production phases, illustrates the emphasis. The record of the aerospace companies on cost control indicates less concern for profits than for survival or sales. The investment structure of the aerospace companies does not put heavy pressure on management to provide more profits. The personal remuneration and personal power of the managers has been tied more closely to the sales than to the profit level. J. L. Atwood, onetime chief executive for North American Aviation, said reputation was the motivation for management.² Finally and most important, the government as customer, with its retroactive pricing, limits profits; consequently, emphasis on them is somewhat fruitless. David S. Lewis, when he was president of McDonnell, said: "In this industry, disaster always seems just over the horizon."³

It is natural, then, that diversification, which is even more important to survival than design competence, has received great, though uneven, emphasis. The possibilities of diversification have been to (1) diversify within the aerospace industry by making aircraft plus missiles or space vehicles or all three; (2) enlarge interests within the broader defense industry, in shipbuilding, for example; (3) acquire more variety in aircraft by building commercial or general airplanes; (4) expand into technologies in which the aerospace industry science and engineering provide an initial competence, such as basic research or avionics, or engines; (5) develop fields related to airframe production process, such as aluminum boats; and (6) acquire totally unrelated endeavors to obtain stable sales or, preferably, those counter-cyclical to the aerospace business.

These are all reasonable approaches, and all have been tried with varying degrees of vigor and success. When the efforts have been very successful they have often been counterproductive because the original business has gone into sharp decline, leaving the company undiversified again.

RECONVERSION DESPERATION AND IMPROVISATION

Besides commercial aircraft there was widespread entry into the general aviation market. Convair, Fairchild, Grumman, Lockheed, North American, and Republic seriously studied or entered the field. The general airplane market boomed in 1946 and collapsed the next year. Soon after, all the great aerospace companies had cut their losses and withdrawn from this market and have not reentered it on a large scale.

North American tried to diversify into fields related to its production processes. President E. H. Kindelberger liked to relate that the company examined the Sears, Roebuck and Montgomery Ward catalogs to find products it could make. After a selection was made, it was analyzed for cost. North American found its production costs would run 30 percent higher than retail prices and the whole idea was abandoned.⁴

Despite the other aerospace companies' lack of civil marketing skills and organization, they tried a wide variety of retail and industrial products. Some were internally developed. Others were acquisitions which appear, for the most part, to have been haphazard or opportunistic purchases. Curtiss-Wright entered into photographic equipment, metals, and clutch businesses and made a small profit. Convair, Douglas, and McDonnell explored the prefabricated house business but did not enter. McDonnell was the only company which did not diversify. Douglas and Boeing limited their diversification to a return to commercial airliners. Convair made kitchen ranges and freezers, transit buses, and auto and marine engines besides its light plane, a flying auto. These investments grew to $19 million out of Convair's total assets of $81 million, but the firm's losses were large. Republic built engines. Fairchild made radio cabinets, small boats, auto trailers, and four-wheel velocipedes for a toy company. The results were unsatisfactory. Grumman made aluminum canoes, fiberglass boats, and truck bodies; Lockheed kept ownership of the Pacific Finance Corp., a consumer finance company, and did well; Martin went into plastics, photo emulsion, and light panels used as structural material; Northrop made a motor scooter, light metal goods, and small engines, but its losses on these ventures ran to more than a million dollars, a heavy figure for a company whose sales were under $30 million a year.

These miscellaneous diversification ventures into the private market by the aerospace companies, used to selling only to the government or the airlines, resulted in a dreary record. Because they were, first of all, aircraft companies, they probably neglected their less glamorous sideline operations where different production and sales techniques had to be acquired. Even in a sellers' market, when businessmen could sell almost anything they made to satisfy the pent-up demand from the war, the aerospace manufacturers managed to lose money. Most of the ventures had been abandoned by 1948, ending a unique period in the aerospace industry. Never again would it try to enter such varied fields as it did in the immediate postwar years.

Two companies did find a new road to the future by diversifying in this period. Convair, as already noted, started the ICBM Atlas, which was to lead the company to the missiles and space fields. North American believed that there was a future in missiles and established corporate units for avionics and rocket engines. North American's later successful leadership in these fields, and its related R&D work, ultimately transformed the company basically from an aircraft to an R&D one.

With the resurgence of military aircraft business and airline expansion, the fears over survival were temporarily allayed, and the aerospace industry's only important diversification was again the airliner. Boeing and Martin lost large sums on their attempts to get pieces of the business, and the limited extent to which the diversification succeeded even for the successful airliner builders can be seen in Lockheed's record: from 1948, when government business turned upwards, through 1955, when new markets were opening and jetliner competition began, Lockheed averaged a little over 80 percent government business. In the diversification efforts since then, aerospace companies have consistently had a goal of no more than 50 percent government business. The constancy of this very round figure over many years and from several companies indicates it is a purely intuitive figure. The long record of crisis and failure in the aerospace industry since World War II suggests that 50 percent government business is probably too high for a reasonable level of risk.

THE SECOND WAVE OF DIVERSIFICATION

Under Robert E. Gross, Lockheed undertook a diversification program for rapid growth as well as security, and the result was a company much like General Dynamics. Lockheed bought out a shipbuilder, hoping to get construction work which it believed would be counter-cyclical to the aerospace business; it won the major Polaris missile contract; and it started electronics and rocket-engine endeavors.

The Martin Company evolved in a similar manner. Despite strenuous efforts it was forced out of the commercial aircraft market. It repeatedly lost bids to build military aircraft, and that business shrank.⁵ With the end of flying-boat production in 1959, Martin was, except as a subcontractor or rebuilder, out of the airplane business. While it was struggling with its dying airplane business, opportunities in missiles opened. For ailing Martin there was little choice; it secured a contract for the back-up liquid-fueled ICBM, the Titan, and entered vigorously into the missiles and R&D fields. In 1961 it followed General Dynamics' example and acquired American Marietta Company, a construction and construction materials firm. The new organization was called Martin Marietta. Martin thus joined the aerospace companies which have become diversified into the non-airplane parts of the industry, maintaining a substantial non-government line.

North American, as noted, entered into the missile and R&D fields immediately after World War II, and as these lines expanded in the fifties North American prospered and grew. But it exhibited the self-defeating aspects of diversification: as the new fields expanded, North American's aircraft production withered away. With the end of F-100 production, the manufacture of major combat airplanes stopped. North American won only bids to develop the hapless XB-70, the prototype of which was finished in 1962, and the aborted XF-108, sacrificed by the Air Council in 1959 in an effort to save the XB-70. Thus, after North American's successful penetration of new markets, it found itself practically without the old, at least for well over a decade.

The Martin Marietta B-57 is distinguished as Martin's last major aircraft production effort and as the only important foreign design adapted for American military use after the Second World War. Courtesy Martin Marietta Corporation.

North American's unwilling withdrawal from the military aircraft market after years as a major company in the business was paralleled by Boeing and Douglas. Boeing's triumphant conquest of the commercial airliner business occurred at the same time that its decline in military aircraft sales began. Boeing had specialized in the big bomber and was unable to win contracts with other types of aircraft when the Air Force was forced to stop buying big bombers in 1962. The company had gotten into missiles early with its unmanned airplane, Bomarc, and it was able to stay in missiles by winning development of the Minuteman. Boeing's government business remained high until it finished its production contracts on the B-52 and KC-135. Similarly, Douglas' losses of military aircraft business coincided with the beginnings of the jetliner age. Its government business was 82 percent of sales in 1954 but only 53 percent by the end of the fifties, despite a good start in the missile business.

Douglas deliberately passed up one diversification field, avionics, believing it would be better off staying with its specialty, airframe design and production, and getting its avionics from suppliers. Other aerospace firms took different courses. Avionics is a more critical part of missiles than of aircraft. A natural result was that, when missiles began to boom, avionics companies like Hughes and Raytheon bid to be prime airframe contractors. Most existing airframe firms believed that to be able to compete with these entrants into the industry they had to enter the electronics business. It was not a radical step, since by 1954 18 percent of airframe company engineers were doing avionics work. Most airframe firms did enter competition for both government and non-government electronics business, even though they were ordered to stop in 1955 by the Air Force under a vague threat of unnamed reprisals.

Northrop was one such company. Although its F-89 interceptor had a long production run, it was not highly regarded by the Air Force. Its unmanned aircraft was the hapless Snark. Northrop turned to the light weight fighter field in 1954, producing on its own initiative what was to become the F-5. Along with all other lightweight designs the F-5 was disliked by the USAF, but it achieved success in foreign sales and saw some use in the Vietnam War. A version of this aircraft became the popular Air Force T -38 trainer, but trainers rate low as military aircraft. Northrop got a new president in 1959, Thomas V. Jones, who believed Northrop must cease its reliance on the aircraft field, in which its success was not clear-cut. The aircraft line was retained, but Jones, an engineer, took Northrop further into specialty technology fields, into avionics R&D. Northrop has done well since. Its F-5 and T-38 were better received than the F-89 and the Snark, and its diversification has ended its dependence on government business, which was at about 50 percent of sales in the early seventies.

In the fifties Grumman lost its position as the premier maker of Navy fighters, as McDonnell and Vought produced superior designs. Whereas Northrop tried to become a lightweight specialist, Grumman sought to carve a secure niche by building unusual workhorse aircraft: antisubmarine, aircraft carrier transport, and amphibian airplanes. Grumman never gave up on the naval fighter, however, and its F-14 was an important aircraft in the seventies.

The missile boom of the fifties led to a wide variety of types, with a cost range lower than aircraft, a situation that facilitated the entrance of non-airframe companies into the field. And since missiles were a follow-on technology to aircraft all the airframe firms except Republic participated in this initial boom. By the beginning of the sixties, the second wave of diversification in the aerospace industry had resulted in a pattern.

Figure III is rough and it is not quantified, but it does illustrate two points, The technological revolutions of the fifties had provided a natural encouragement to diversify, yet some firms attempted to go on beyond the new technological openings, The process was spurred by the wave of cancellations of defense programs in the summer of 1957 which had sent a chill through the industry. Also, it can be seen that the extent of diversification varied widely within the industry at that time.

THE RECURRENT EFFORTS

FIGURE III PATTERN OF DIVERSIFICATION, EARLY SIXTIES

+ Fairchild's missile contracts had been canceled by the sixties.
++ Northrop abandoned large missiles as a prime after Snark.

A special effort to get into space was made by two companies that had not been aggressive in diversifying before, Republic and Douglas. These companies recognized belatedly that failure to broadly diversify had been a mistake for them in their particular industry position, and they now invested capital in facilities to enter the space field. For Republic it was to no avail. With the termination of its F-105 contract in 1964, Republic was badly hurt. It was bought out by Fairchild in 1965, who wanted Republic for its engineering staff and production facilities. Fairchild also made other moves to diversify, including acquisition of a helicopter company, Hiller.

Despite Douglas' late efforts to diversify, it became more specialized in the sixties. Its military aircraft line shrank to its classic design, the A-4, and loss of military aircraft production was a heavy blow to profits. Two main attempts to sustain or improve its government business were Skybolt and the Manned Orbiting Laboratory (MOL), but Skybolt was canceled in 1962 and the MOL in 1969. The military business stayed at a low level: in 1966, of Douglas' sales, only 22 percent was to the government and only a third of that was for aircraft. When Douglas' commercial airliner business skyrocketed in 1966, causing cash problems, the level of government sales was of little help. Thus a lack of sufficient diversification contributed to Douglas' failure and absorption by McDonnell. More diversified General Dynamics survived its 880/990 crisis, which was about the same size as Douglas' 1966 DC-9 crisis; and Lockheed, also broadly diversified, surmounted its smaller Electra crisis.

Lack of diversification contributed to Douglas' failure, and this weakness dominated its successor's plans. McDonnell had sought diversification since the forties. It had built a succession of fighters for the Navy, but James S. McDonnell, or "Mr. Mac," McDonnell's chief executive, felt insecure in having only that business. His first move was to attempt to sell to the Air Force. Two 1948 attempts, the XF-85 and XF-88, were not bought. The Air Force wanted the XF-88, but the Navy said it needed McDonnell's full productive capacity. The XF-88 was upgraded to the F-101 of 1954, and this was bought by the Air Force, as was the later F-4. McDonnell's next efforts were civil. It offered a jetliner design and brought to the prototype stage a business airplane. Both attempts failed. At about the same time, McDonnell entered the missile field, and, from the beginning of the space efforts, James S. McDonnell saw the desirability of manned space flight. The company began early work on a spaceship, and when NASA asked for bids McDonnell had gone furthest in design and won the competition for Mercury. Still concerned over diversification, Mr. McDonnell bought up Douglas shares in 1963 hoping to enter the commercial airliner field through merger. Douglas repulsed his efforts at this time, but when Douglas collapsed in 1966 McDonnell tried again and succeeded against the other bidders by offering the largest sum at the earliest time. With the acquisition McDonnell restored in one company the balance of government and commercial business that Douglas had lost in the fifties.

The leading jetliner builder, Boeing, has continued its efforts to find more of the same kind of balance. Unable to win military aircraft contracts in the sixties, Boeing sought to regain a place in the business by acquiring Vertol, a helicopter manufacturer. This has been successful, but the business is slight by comparison with Boeing's former military aircraft business. Boeing continued in the missile business with Minuteman and the Short Range Attack Missile (SRAM), and the space business with its Saturn first-stage booster. Yet the share of Boeing's sales which were government business continued to decline, from 100 percent in the early fifties to around 20 percent in the early seventies. Renewed efforts were made to find new directions, and by 1971 Boeing had considered 160 proposals for possible new products or services. Among them were police radio scramblers, desalting of water, community developments, computer services, and construction.

In contrast Lockheed has been highly successful in winning government business but has never resigned itself to having lost out in airliners. In the decade of the sixties Lockheed hoped to recoup by winning Air Force transport contracts and selling civil variants to the airlines, another example of the continuing attempts by aerospace companies to shift air, liner development costs to the government. Lockheed won both the C-141 and the C-5A competitions. These, with the C-130, have given Lockheed the kind of dominance on military transports once held by Boeing in bombers. But as a means to an end this accomplishment has been a total failure. The airlines have shown little serious interest in the high-wing Air Force transports, believing that the military virtues of nose and tail loading, high-wing structure, and short field performance result in an uneconomic burden for airline operation. To reenter the airliner field, Lockheed has been forced to take its C-5A data and design the L-1011. This persistent effort to reestablish itself in commercial airlines represented nearly its entire diversification effort in the sixties. As can be seen by Figure III, Lockheed was relatively well diversified by 1961, when Robert E. Gross, its long-time leader, died. With his death, the diversification drive ended. His successor, brother Courtland, believed an aerospace company was ill-suited for non-defense work because of its emphasis on science and reliability. He also believed that diversification could not contribute to the support of idle defense facilities. In the fifties and sixties Lockheed was highly successful in winning government projects and completing them, and the management probably began to feel secure. Unfortunately, one diversification effort, shipbuilding, had become a cripple. Almost $16 million was lost on this operation in 1966. A disastrous series of setbacks carrying into the seventies-early termination of the C-5A production, cancellation of the Army Cheyenne helicopter, shipbuilding losses, and the Rolls-Royce receivership which delayed the engines for the L-1011-brought Lockheed to its knees. The management had probably believed the odds were unlikely for such simultaneous disasters, and the circumstances demonstrate that diversification is only a partial answer to survival for the aerospace industry.

Lockheed's bid to diversify and reestablish itself in the airliner market was made with the efficient L-1011 TriStar. Courtesy Lockheed Aircraft Corporation.

That diversification can even be a handicap is shown by General Dynamics' major troubles with the Quincy shipyard in the sixties, although the company's surmounting of the crisis was undoubtedly helped by the healthy parts of the conglomerate. By 1970 shipbuilding write-offs had totaled $237 million. General Dynamics has not sought further diversification in the decade except through cautious feelers to the airlines about paper proposals on airliners. Its caution is understandable because of the loss on its 880/990 program.

With the decline of its non aircraft lines, mostly with the end of Apollo, Grumman was, against its will, specializing again in military aircraft. Its diversification into an air cushion vehicle, prefabricated housing, pleasure boats, aluminum truck bodies, and business jets had not provided an adequate replacement for defense business in the early seventies. Unable or unwilling to cut the overhead from the other programs, Grumman tried to transfer their costs to the F-14 project, precipitating a crisis with its traditional customer, the Navy. The desperate Grumman illustrates again the weakness of the company with only one major product.

Martin, which diversified out of aircraft, sought at intervals in the sixties to sell new airplane designs of its own. Unable to do so, it remained in the early seventies much as it was a decade earlier.

North American also tried to diversify by regaining some aircraft business. It produced trainers (T -2) and an attack plane (OV -10), and it won the B-1 competition. It also made cautious overtures for airliner business, for the perennial attempt at a DC-3 replacement, without success. Concerned about North American's near total dependence on the government for sales, its top executive, J. L. Atwood, hoped for a merger with a civilian market company in the years after 1959. Atwood was nervous despite North American's outstanding successes in getting contracts in the space program and R&D, which gave it sales of over $2 billion from 1964 on. That Atwood was well-justified was shown in 1967. The investigation of the fatal Apollo ground fire led to highly critical attacks on North American, by NASA, for a lack of technical and managerial competence. These attacks seriously impaired North American's reputation with business and government. This blow came as North American merged with Rockwell Standard, and the merger probably came just in time to save North American. A downturn began in 1967, and Apollo started to close down in 1969. Until the B-1 award of 1970 and the space shuttle in 1972, the North American part of the new company had a grim outlook.

North American had not married in haste, and it had chosen a company which had large automobile interests. Thus North American Rockwell is the first of its kind in recent years: a company interested in both aerospace and autos. The aerospace and auto industries can be complementary and somewhat counter-cyclical to each other, and each possesses know-how and attitudes of use to the other. Aerospace companies have been more aggressive in technological advancement, and the auto companies have been more cost and marketing conscious. Atwood's merger achievement .may prove to be one of the best business decisions ever made in the aerospace industry.

THE FALSE HOPE

WHY NOT MERGER?

The lack has not been for a complete absence of proposals, some of which have been referred to above. In 1945 Curtiss-Wright tried to merge with Lockheed, but negotiations broke down over Curtiss-Wright's complicated capital structure. In the spring of 1946 Lockheed and Convair considered a merger, so as to have one company offering a full spectrum of airliner types; the proposal was shaky because of an unsteady securities market and Convair's alarm over a grounding of the Connie, but the merger was actually called off because the attorney general objected on antitrust grounds. In 1948 weak Convair approached both North American and Northrop and was rebuffed. In November 1948 Curtiss-Wright approached Boeing, declaring that its management needed strengthening; but Boeing's president said Boeing could not afford to dilute its management, and he also declared that mixing the airframe and engine businesses was undesirable.

Three years passed before there was renewed merger interest. Again the proponent was Convair, seeking to assure continued possession of large plant space after B-36 production ended. Convair's president approached Kaiser-Frazer because it owned Willow Run and other airframe facilities. Also, Kaiser's losses provided tax credits, the company had a reputation for engineering skills, and OdIum saw an advantage to joining the aircraft and auto businesses in one company. The prospects changed with creation of the excess profits tax, for then profits were higher without merger.

It was eleven years before there was another attempt. This time McDonnell quietly bought up shares in Douglas so as to join its own government business with Douglas' commercial production. The Douglases, father and son, rejected the proposal, however, and were able to block it. They gave these reasons: separately the companies would do more business; consolidation would produce no economies; Douglas' customers would be driven off by a merger with McDonnell; and there would be no gains in diversification.⁷ These rationalizations are difficult to accept at face value, and they have been proved wrong by the eventual absorption of Douglas by McDonnell.

In all these negotiations there was no overt involvement by the government, except in the one case where the attorney general intervened. The government role is difficult to assess because it was often indirect. When Stuart Symington was secretary of the Air Force, from 1947 to 1950, he and high-ranking officers in the USAF took the position that there were more firms than necessary in the aerospace industry; they suggested that mergers should be effected. This line of reasoning was again presented in 1970 and 1973 by Deputy Defense Secretary David Packard, who also specifically suggested that Lockheed merge to solve its problems.

There is no evidence that this gratuitous managerial advice has ever been taken seriously by the aerospace companies. What is surprising is that the antitrust laws are not emphasized by Defense Department officials, for the Justice Department has shown an aversion to aerospace mergers. Besides the interposition by the attorney general in the 1946 Lockheed-Convair proposals, Justice Department approval of the North American-Rockwell merger came only after Rockwell agreed to divest itself of its jet general aviation business because North American had a competing line. McDonnell was allowed to absorb Douglas because it lacked commercial business and Douglas had few government sales. The dominant governmental attitude is to oppose mergers, in contrast to the British position.

As for business reasons, the strongest influence against mergers has probably been the widespread presence until recently of founders as company leaders within the aerospace industry. Such men would have a natural reluctance to put an end to their creations.